Technical Analysis Tools

I've been slowly developing a system that I'm using to trade, and it's completely dependant on technical analysis.  Technical analysis is the theory that you can predict the future price of a stock based on the past price of the stock.  If you trade on technical analysis indicators, you're not looking at the company at all.  Indeed, when I pick a stock, it's just a symbol of three to four letters.  I don't really care what the company does or it's fundamentals.

I think looking at the fundamentals of a company would be way too time intensive.  I could see it if you had specialised knowledge.  Say, if you were a mining executive and you only invested in mining companies.  But otherwise, there's just too much to know. 

There are a lot of technical analysis indicators.  However, I only look at two things - Simple Moving Averages, and True Ranges.

A simple moving average tries to smooth out a stock price over time.  You would take the stock price over the last 30 trading sessions, add them all together and then divide by 30.  That would be the current average.  The next day you would do the same thing, except the new day would be added and the first day of the last average would be deleted.  If the stock is rising, the average will also rise, and vice versa.  However, day to day fluctuations will be smoothed out.

One danger of using a moving average is that it's a lagging indicator.  It is quite possible for a moving average to be moving in one direction while the stock is moving in the other.

The other indicator I use is the true range.  It is the largest of the following three values:

• High value for the day minus the low value for the day.
• Difference between the high value of the day and the previous day's close.
• Difference between the low value of the day and the previous day's close.

This gives you approximately how big a trading range the stock trades in a day.  You can then use that number in a simple moving average to give you a long term idea of how much a stock fluctuates day to day.

I'll explain in more detail how I use these indicators in later posts.